Personal finance bloggers are in love with the topic of net worth these days. It's their main measure to see how well you're doing financially, but is it really the right measure? Is there something else better out there? I certainly think so. Ask me, and I'll tell you to focus on your future value.
More articles on net worth:
Focus on Your Future Value, Not Your Net Worth
You've been reading personal finance blogs for years. And you've continually followed that same old tired advice—
Get out of debt.
Save money.
Build your net worth.
While this isn't necessarily bad advice (I give it all the time), I think it's time to broaden your horizons a bit and learn something even more meaningful. It's time to branch out beyond the simple net worth calculation and bring on a whole new formula that will not only let you gauge how well you're doing in the present, but how wealthy you'll become in the future.
It's time to focus on your future value.
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What is Net Worth?
Before we get too far ahead of ourselves, let's take a step back and make sure we know what we're talking about.
For starters, what does the term "net worth" really mean?
Net worth is simply what you own minus what you owe. Said a more sophisticated way—your assets minus your liabilities.
Net worth = Assets - Liabilities
If you're a young college grad renting an apartment and the only asset you have to your name is your car, you'd simply take the value of the car and subtract how much you owe on it. Let's say according to Kelley Blue Book, the private sale value is $6,000 and you owe $2,000. Your net worth is $4,000.
Do you own a house?
Another car?
Have a 401k?
Simply apply the same formula to each asset and add up the individual net worth values. The bottom-line result is your overall net worth. But you know what—who really cares?
Read more:
Why I Don't Care That Much About Net Worth
Net worth is a great measure for how much you're worth at this very moment, but it does very little in the way of predicting your future worth. Let me illustrate with a cute little story (that you'll hopefully remember for life).
Jim and Tom work in the same office. They're both accountants, are the same age, and you know what? They even have the same net worth: $300,000. Everything about them seems the same, but in reality, their futures are on totally different paths.
Jim's net worth is the culmination of the following:
Primary house
Cottage
Two very nice cars
401(k) investments
Medical debt
Tom, who is also worth $300,000, has a little different summary:
Primary house
Investment property
Two mediocre cars
401(k) investments
No debt
With an equivalent net worth, they're basically in the same place financially, right? Um, not even close. (Spoiler alert: their end result is millions of dollars apart.)
What is Future Value?
Let's pause on the story for a minute so I can give you a true visual of what future value actually means. (It's so important, I don't want you to miss it.)While net worth is a calculation of where your financials are at currently, your future value is a measure of where you'll end up if you keep spending your money like you do today. And, as you'll see in just a minute, these two measures are very different. If you would ask me which one you should pay attention to, I'd tell you to focus on your future value every single time.
How is Future Value Calculated?
The main reasons most bloggers don't say anything about your future value is because—
They may not know about it themselves.
It's not that easy to calculate—heck, some so-called "experts" even get stumped with the calculation from time to time.
And it's a little difficult to explain to someone that's just looking for an easy read on a solid personal finance blog.
But thankfully, all of you are smarter than the average reader. (And, on top of that, I'm getting pretty decent at explaining things so that aren't so easy to understand.)
All combined, I think we'll get through this, and you'll be far better off at the end of this article than you were in the beginning. And that's the whole reason you seek out these personal finance articles in the first place, right?
So let's move on—
The Future Value Calculation
To calculate your future value, you'll need to—
List out all the items that make up your net worth (your assets, savings, debts, and so on).
The value of each item.
Know how much you're putting into each investment.
Have an idea what each investment will earn you (on average).
Know how long you'll have that item.
So, let's say you have an investment:
You have money in a 401(k) through your work.
The value is $40,000.
Each year, you put in another $5,000.
On average, you earn 10% each year.
You plan to keep putting money in for another 20 years.
And that's it. With this information, you can figure out the future value of your investment.
Here's the formula—
FV = PMT*[((1+(interest %))*years-1)/(interest %)]
Like I said—the formula can be a little daunting. Thankfully, I built a tool so you can simply input your numbers and get a result without the professional mathematician exam. Download the free future value tool here.
Read more:
Back to Jim and Tom and the Focus on Future Value
Remember we introduced you to Jim and Tom at the beginning of this article? Don't worry, I didn't forget about them and their future value results.
Jim had—
A couple of nice houses.
Some expensive cars.
A couple 401(k)s that weren't overly impressive.
Some debt that he just didn't get around to clearing up yet.
Here's Jim's future value in a nutshell:
In 20 years, Jim's $300,000 net worth will become $1.9 million. Pretty solid, right? Well, sort of.
Before we jump up and down for Jim, let's take a look at Tom's numbers. If you recall, Tom had—
A modest house.
A rental property.
Some non-flashy cars.
Two 401(k) investments.
Absolutely no debt.
Here's how Tom's future value is looking:
In twenty years, Tom's future value is projected to be not $1.9M like Jim, but over $5 million.
How is This Possible?
How is it that Jim and Tom could be worth the same amount of money today, but have such a discrepancy just 20 years later?
It's simple.
Your future value has little to do with your exact net worth, but it has everything to do with where you're investing your money.
Jim likes new cars and fancy houses, but—
Cars depreciate.
Houses appreciate slowly—at a rate of just 4%.
Tom likes his rental property, his simple residence, and his mediocre cars, which means—
He wasn't losing much money to depreciation.
He had an asset that was actually making him money.
His lack of debt payments left him with plenty of funds to invest more heavily.
How is Your Future Value Looking?
You may have thought you were sitting pretty because of your net worth, but your reality might not be as rosy as you once thought.
It's time to find out for sure. Download the "Focus on Your Future Value" Excel sheet.
Enter the number of years until your retirement at the top.
Fill in the other peach cells.
Then scroll to the bottom to see your future value.
What is a Good Future Value?
If you're retiring in the next few years, a little over a million bucks is a good target.
If, however, you're not retiring for another 20+ years, your goal should really be $2–$3 million (thanks to a little evil green figure called inflation). Anything below these targets, and you might want to focus on your future value a bit harder than you are today.
(Related: Retirement Savings by Age—Are You on Track?)
So here's the big question—how are you doing with your future value?
Download the tool and find out!
SOURCES
What’s Your Net Worth Telling You? (n.d.). Investopedia. Retrieved March 21, 2023, from https://www.investopedia.com/articles/pf/08/ideal-net-worth.asp
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